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Echo Partners Community Bank Blog

    Unprofitable deposit accounts

    Unprofitable deposit accounts.

    Like most bankers you probably have a sense that some of your deposit accounts are unprofitable. Based on my experience I’d guess it’s about half. But let’s not get hung up on specific numbers. Instead let’s look at why you have unprofitable deposit accounts.

    There are many reasons for unprofitable deposits but the biggest reason is probably using aggregate measures (like balances) instead of instrument-specific measures (like actual transaction behavior) to judge profitability.

    What this boils down to is that if you can’t measure deposit profits you can’t manage deposit profits.

    Another big factor is failing to set a specific deposit profit target. We’d never consider not setting a profit target for loans or investments, but somehow when it comes to deposits (80%+ of typical bank balance sheet footings) we overlook it.

    It’s hard to hit a profit target that you don’t set.

    The third factor is pricing. Bankers do a poor job of setting prices based on objective factors and often default to rules of thumb or “competition” as a shortcut. But the truth of the matter is that without instrument-specific measurement and absent a specific profit target that’s often all we have left.

    Improve your measurement, goals and process and watch your deposit profits increase.

    Your deposit quality never gets better

    Your deposit quality never gets better.

    It only gets worse…

    …Until you implement deposit profitability.

    As banks near you start improving their deposit quality some of their lowest quality accounts will decide to change banks. Guess where these money-losing lower quality accounts will go?

    That’s right. They’re going to your bank.

    They’re going to reduce your profitability and water down your deposit quality. And this happens over and over again while banks in your market improve their deposit quality. Until you decide to join them and insist on earning a fair profit on your deposit services.

    But once you implement deposit profitability your deposit quality starts to improve. That’s a natural result of focusing time and attention on the issue of deposit profits. Here’s how it works:

    You have a base amount of quality profitable deposits that exist now in your bank. All remedial actions are focused solely on the lower quality, less profitable accounts.

    In response to your efforts these accounts can a) Change behaviors to avoid fees, b) Pay fees or c) Resist.

    Any account in the “Change” or “Pay” group automatically increases both your deposit quality and profitability. The “Resist” group will itself mostly change or pay, but any account losses will come out of this group.

    Why you don’t have deposit profitability

    Why you don’t have deposit profitability.

    Deposit profitability can add 30-50bps (or more) to your annual profits year after year. But if deposit profitability is such a great idea why don’t you already have it at your bank?

    There are 3 main reasons.

    1. Deposit profitability is a big bank project. Big banks engaged big consulting firms with big data experience to custom craft deposit profitability solutions. Until recently you just didn’t have the computing horsepower, algorithms and expertise to measure instrument-specific individual account profitability. Now community banks can have these same powerful and profitable insights.
    2. Legacy core systems held you back. All the data you need to calculate instrument-specific P&L statements for each and every account is tucked away deep within your core system. Core providers could have made this readily available for you but chose not to. Now we have templates that give a road map to the exact data needed.
    3. Deposit profitability is a new concept. We think we already know everything about deposits. It’s hard to shift from trusted aggregate measures (like balances) to a new instrument-specific focus on profits. We’ve successfully done it before with IRR models. Now we need to make the instrument-specific shift with deposits.

    Compliance: police or attorney?

    Compliance: police or attorney?

    Too often our view of bank compliance is like our view of the police. They exist to tell us “No” and keep us from doing bad things.

    That’s understandable given the events of the past decade. But it also prevents us from getting the most out of our compliance resources while holding back the professional development of our compliance team.

    My suggestion is that a more accurate and rewarding compliance posture results from viewing compliance more like lawyers.

    People engage lawyers for 2 main reasons.

    • You have a firm plan of action that seems correct but want to confirm if it is allowable or compliant.
    • You have a firm goal that has some potentially troubling aspects and want to know how to achieve it without causing problems.

    These 2 look a lot alike but there’s a subtle difference. One focuses on approving an action while the other focuses on achieving a result.

    Your compliance team should focus on figuring out how to allow top management to achieve their strategic goals, not on saying “No. You can’t do that.” That’s how you increase clout and visibility.

    Of course there will always be occasions where the answer is simply that you can’t do something, but the main compliance focus should be on telling you how to achieve your goals. That’s better for everybody.

    Individualize at scale

    Individualize at scale.

    Deposit profitability is not about a better way to aggregate and segment. It’s about how to treat everyone individually according to their profitability.

    So how do you treat everyone individually when you have thousands or even hundreds of thousands of accounts? You use account types.

    Account types and account terms allow you to individually assess fees, administer minimum balances and limit allowed transactions based on the individual behavior of your accounts at scale. And those depositor behaviors directly establish and ultimately define the profitability of each account.

    Need more fee income? Change an account term to assess a fee.

    Excessive transactions dumped on you? Change an account term limiting allowed transactions.

    Need to improve profitability with price sensitive depositors? Change an account term requiring a higher minimum balance to avoid fees.

    Best of all managing by account types and terms is a compliance-friendly way to makes mass changes to lots of individuals.

    But I must caution you. Account types and terms are a powerful tool. Make sure you understand who in the bank might be impacted. A little preventative maintenance on your relationships helps limit any collateral damage. And the higher profits help smooth any rough spots.

    A picture is worth a thousand words

    3 GroupsA picture is worth a thousand words…

    …That’s true with deposit profitability too. Especially when it involves how to translate deposit profitability numbers into more profit at your bank.

    Take a look at this graph showing individual account profitability starting from most profitable to least profitable.

    The 3 groups shown in the picture require very different handling. Let’s go through them 1 by 1.

    • Group 1 on the left includes your very highest profit accounts. Not only are they individually very profitable but they aggregate into over 100% of your bank’s total profit. You know how to handle them…Individual personal attention designed to further build your relationships. If you double their profit you will double the bank’s profit.
    • Group 2 on the right is the other extreme. They are the handful of your largest individual money losing unprofitable accounts. They also require individual attention to uncover and correct whatever is causing their lack of profitability (often excessive, expensive transactions not properly priced).
    • Group 3 contains the overwhelming majority of all your accounts. They fluctuate from profitable to unprofitable and include a lot of marginal accounts. There’s only 1 way to appropriately manage this many different accounts and that’s via account type changes.

    We’ll talk about that next time.

    What next?

    Results Concept. Word on Folder Register of Card Index. Selective Focus.-1What next?

    We’ve calculated our deposit profitability numbers and produced instrument-specific detailed P&L statements on each and every deposit account. Now what?

    Start with “Four Ds” segmentation based upon profit (vertical axis) and balance (horizontal axis) for each account. Make a simple 4 quadrant segmentation as follows:
    • Q1 is closest to the origin. Q1 has below-target profit and balances. We must decide how to fix Q1.
    • Q2 has higher balances but doesn’t meet our profit targets. We need to detect the cause and correct it.
    • Q3 meets our profit target despite having small balances. We want to develop Q3. They already earn profit for us so our goal is to grow their balances.
    • Q4 are our favorite accounts with both higher profits and balances. We want to defend these key relationships at all costs.

    Add the “Q-score” to your customer record and your client-facing staff can start using profit to make better decisions starting immediately.

    If someone walks into the bank requesting a price concession your rep looks them up on the system to see what sort of balances they carry. If they have big balances everything is set up to grant their request. But if they are a “Q2” (substandard profits despite higher balances) your staff might push back against that request.

    Stop treating everyone the same

    Hand with marker writing the word Do You Know Your Customers?Stop treating everyone the same.

    Some bank customers are better than others. And by better I mean more profitable. It’s time to start treating your customers based on their profitability.

    Businesses all across America do this. Airlines, grocers, pharmacies, casinos, restaurants…even the local sandwich shop. They reward their most profitable customers with extras and bonuses just for them. And they motivate and cajole their less profitable customers to prod them towards higher profitability.

    You should do the same at your bank.

    Make sure you endlessly reward your most profitable customers. And relentlessly push your less profitable customers toward higher profits. Simply by focusing on profitability you will improve it.

    But there’s just one problem…

    …You don’t know their profitability.

    Without knowing their profitability you risk rewarding and penalizing the wrong customers. That’s counterproductive.

    Don’t worry. This is easy to fix.

    Unlike all those other businesses you already have all the data you need buried deep within your core system. While you’ve been focused on other things your core system has been silently capturing all the customer data you need.

    It’s an easy next step to use it to calculate detailed instrument-specific P&L statements on each and every account.

    New accounts don’t add promised profits

    Piggy bank broken with money inside on white backgroundNew accounts don’t add promised profits.

    Too many bankers fall for the siren song of the new account conjurer. Why? Because we associate balances with profits and the number of new accounts is a metric that is measurable. We do the flawed math in our heads and expect newfound deposit riches.

    So although 50%+ of our deposits are unprofitable, we think spending money to get more of the same kinds of deposits will deliver improved profits. Or that paying expensive deposits rewards (to get customers to do more of what they already want to do) on pricey small accounts will result in greater profitability.

    What happens? The final results never quite match the front end promises.

    The reality is that unless you change your approach you’ll be locked into unprofitable deposits forever.

    You need a new target. Don’t just look for new deposits…Look for new profitable deposits based on the exact characteristics of your existing profitable customers.

    Start by measuring instrument-specific deposit profitability for each and every account. Then closely examine your profitable accounts for the specific behaviors that drive their profitability.

    Find more like them and you’ve got a good chance to beat the odds and add more profits instead of just adding more accounts.

    Don’t mistake balances for profits

    Blue & Yellow Tape MeasureDon’t mistake balances for profits.

    It’s easy to do. We’re so used to thinking of deposits using an aggregate measure like balances. We convince ourselves that balances are the be-all and end-all of deposits. As if balances told the whole story.

    The only problem is it’s just not true.

    Balances measure deposit quantity while profits measure deposit quality. I don’t know about you but I’d choose more profits over more balances any day. After all we can always get more funding but we can’t always whip up more profits.

    In a perfect world high balances would mean high profits, but we’re not living in a perfect world.

    Instead we’re in a world where bank staff rushes to offer price concessions to big depositors while depositors drop excessive numbers of high-cost transactions on us. Sometimes they work hard just to keep us from earning a fair profit.

    What’s a banker to do?

    The answer is to calculate instrument-specific P&L statements on each and every account. That way you’ll know on the front end just how profitable (or not) any given customer is.

    Once you know their profitability it’s a small step to knowing exactly how to handle almost any customer situation. With better info bankers make better decisions.

    Do you want to grow your bank profits with little to no risk? Click Here to  Discover How

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